The economics of micro-finance

This column is based on my trip to Hyderabad, earlier this year.  Here is part of the introduction:

Microfinance is not actually “micro” in scale. It is far more
organized than the individual moneylenders in poor communities, the
traditional source of finance. Spandana borrows from banks, has about
2,000 employees and deals with about 800,000 loan recipients. The
resulting economies of scale make possible lower interest rates.
Spandana has been lending at interest rates of 10 to 15 percent a year,
while other Indian microlenders may have rates ranging up to about 30
percent a year. Traditional moneylenders receive 5 or 10 percent a
month or more. It is no wonder that Spandana has grown.

Spandana
seeks to earn a profit through higher repayment rates. Unlike the
moneylenders, Spandana lends to small groups of 5 to 10 people rather
than to individuals; each member is liable if other group borrowers do
not repay. The carrot is that good borrowers become eligible to receive
higher sums.

Yes I am a fan of micro-finance.  One overlooked benefit is that the weekly repayments enforce fiscal discipline and responsibility on the borrowing families.  Otherwise the money often goes to deadbeat relatives.  Here is the full article.

Comments

I am mostly in favor of microfinance. However, the argument Ms. Reddy uses that "the final proof of the effectiveness of her programs is that “the women keep returning, three, four times in a row.†" could be used by drug dealers as well. It is not generally seen as a good thing when people keep returning to payday lending companies in the USA.

Tyler, great column in the Times today. I am pretty disheartened to learn that the Indian government is moving to regulate and/or shut down profitable microlenders. This is exactly the kind of private sector-led development solution that has the potential to reach scale and impact millions of lives in a sustainable way (by injecting low-cost capital into poor communities). Why does the Indian government have to go and ruin everything?

I've also blogged about your column here - I would send a trackback, but we turned them off because of spam. Thanks again - and great work.

DK, that wouldn't matter at all to the bank. The banks expect some loans to fail. The average borrower if they know that the loan must be repaid is unlikely to borrow more often then they need. A part of the beauty of microfinance is that once a person proves themselves able to pay back their initial loans they begin to function as microlenders. They have established some level of ccredence with the bank and they can go back to the bank for future loans to be lent out at interest rates of their determination.

Max,

"DK, that wouldn't matter at all to the bank. The banks expect some loans to fail."

Aye, and not necessarily even the unprofitable ones. All depends on what your fixed originations costs look like, what you're charging, and how long before the thing charges-off (if ever.) Frankly, "good" loans at low rates that prepay can be money losing propositions. I wonder if any of the lenders use automated decisioning to cut down on costs. There's clearly less data on these folks than western consumers with bureau files, of course.

Tyler,
There was an article in the last month or so, I think in Business Week
(or maybe Forbes) about micro finance that mentioned a website
where you can deposit as little as $100, which then gets parceled out in small
increments to capitalists. Their track record of paying back their
loans is very good.

_pay day lending is often just a polite way of saying 'loan shark'_

I'll deny your claim, at least. The purpose of a true "loan shark" is only partly to make money off of high rates via a spread over his cost-of-funds, not really. He looks to get the debt compounding to the point where the mark would feel social opprobium simply by admitting the existence of the debt and/or the reson he borrowed the money. (i.e. you're into a shark for $100K because of a gambling or drug problem) At that point, the shark starts extracting "favors", payments-in-kind, etc.

A pay-day lender is charging the borrower out the nose, but ultimately all the same legal protections are in place and the borrower faces no more sanction from either society or the lender for defaulting than any other borrower.

Dear Mr.Tyler, Microcrdit in India has problem but lots of potential.Only viewing from Banker buisness it offers big market.But my experience in working with successful project with commonwealth suggest that repayment and interest alone should not be the yardstic of success in microfinance.It is the devlopment component mainly providing opportunity to genrate income and more importantly to make people BAKABLE.Microfinance is a plateform form such unpreveledge group to have access ti finance and get ultimately mainstreamed in delopement.So far bankers have neglected them,and now wnen they see big business-with large no. of poors in devloping countries,they cry over it!! Microfinance should therfore devope innovative products that suits poor and contribute significantly in devoping poors.In India it has also successfully mobilise savings to a large extent and empowered people,especially women in its real sense.India is big country and trying to devlope appropriate models which are needbased.Any experience to suppliment it/ Thans and congrats for raising some imortant issue.

More on recent development in India's microfinance market:

"Even multinational banks with operations in India like ABN Amro, Standard Chartered, HSBC, and Citigroup are moving into the microfinance sector. They are striking up partnerships with other microlending specialists in India, and there is even talk of creating a secondary market for these loans.

Microloans could be bundled together into larger bond issues and sold to Indian and global investors. If that happens, it could create the kind of liquidity that might take microlending in India into a higher realm."

Sounds promising to me.

http://www.businessweek.com/print/smallbiz/content/aug2006/sb20060822_940979.htm

What all of you are missing is that any lending at interest is evil. All major religions have prohibitions against it for this reason.

When the loans are circulated that is a temporary good thing, however lenders never create the money to pay the interest and since the money supply is finite. Money to pay the interest must come from the principal of someone else's loans this guarantees that the second borrow cannot possibly repay his loan unless he uses a large piece of a third borrowers principal.

This keeps just makes the poor poorer and the rich richer. The lenders don't want the money because almost every country has a private fractional reserve banking system that allows them the create out of thin air all the money the market can use. They want the true wealth which is land, homes, natural resources and capital equipment.

Please become educated about the interest death spiral which can be found from link from my site.

I am an issuer of interest free money.

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